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ETNs (Exchange Traded Notes)

Exchange traded notes are extremely complex securities and financial advisers are required to provide clients with detailed disclosures regarding the risks and rewards of such investments. Various regulators have expressed concerns about exchange traded notes and advised firms that careful disclosures must be made to investors.

Exchange traded notes or “ETNs,” are unsecured debt securities issued by public companies, usually bank holding companies or investment banks. In addition, they are exchange-traded securities that are typically linked to another security or index of securities (a “reference asset”). Unlike an exchange traded fund (“ETF”) investor, an ETN investor has no ownership interest in the reference asset. Exchange traded notes expose the investor to both the market risk of the reference asset and the credit risk of the issuer.

Exchange traded notes are a type of alternative investment. As such, they share many of the risks and problems of other alternatives, such as illiquidity, high fees and lack of transparency. In addition, many exchange traded notes are highly leveraged products that are intended for very short-term trading (or day-trading), and do not accurately track their reference asset over longer periods of time.

Because they are exchange-traded, exchange traded notes (like exchange traded funds) may trade at a premium or discount to the value of the reference asset. Those variances may be significant and can lead to extreme volatility, which has, on occasion, been precipitated by actions taken by the issuer.

An example of this involves an exchange traded note named VelocityShares Daily 2X Short-Term ETN, which purports to deliver two times the ups and downs of the VIX, an index of market volatility. This exchange traded note reportedly lost half of its value in just two days. The share price rose to a significant premium after the issuer announced it would cease issuing shares. Subsequently, when the issuer announced that it would resume issuing new shares, the price snapped back, and investors who bought at a premium were left with large losses.